Q&A: BDC Capital shares the philosophy and strategy behind its new $160-million IP fund

In July, BDC Capital announced that it is committing $160 million to finance intellectual property (IP) development in Canada. With this new envelope of "customized, patient capital," BDC hopes to fill the gap in capital financing for scaling companies with intangible assets. We spoke with Patrick Latour, SVP for the Growth & Transition Capital team and Lally Rementilla, previously the CEO of the alternative lender Quantius and now managing partner for the new IP-backed financing envelope, about what they plan to achieve and why this type of fund is so overdue.

Research Money: The envelope is intended to support IP-rich companies in Canada. How do you define an IP-rich company?

Lally Rementilla: As far as the companies are concerned, when we say IP rich, it's really companies with what we call emerging and established intellectual property portfolios. We recognize that in order to compete globally you need a certain level of IP protection. What we aim to do with this envelope is to really focus on those companies with strong IP strategies, provide them with the capital that will enable them to compete on a bigger scale, and help them achieve what we call “product-market and moat fit.” So you've got not just product-market fit, but you've got a moat of competitive advantage, usually backed by strong IP.

Pragmatically, that comes in the form of companies with already-granted patents. We'll look at their trade secrets and we'll look at their proprietary software because we want to see that strategy really give strength to their market offering. These companies can come from any sector — it doesn’t have to be a hardware or software company. It can be a company in life sciences and medical devices, telecommunications, even consumer products. These sectors do tend to be underserved. They find it more difficult to borrow money because traditional lending has always been focused on asset-heavy companies. Whereas the value in these companies is actually in their intangible assets.

R$: Spell that out for me, the idea of the moat in “product-market and moat fit.”

LR: When you say product-market fit, it’s really having the right product to address the needs of a growing market. We’re adding to that the concept that you also need a moat: a unique product that addresses that market so you can have a competitive advantage that enables you to have longer-lasting supplier relationships with your customers. For example, with consumer goods, you have something so unique and different that you've already increased the cost of entry or the barriers to entry in that product category. Patent protection allows you to create that moat.

R$: There was a report recently that only 2% of Ontario's SMEs held a patent. I've also seen other figures, but either way, it seems like a small pool. How many IP-rich companies are there in Canada? Is it a narrow pipeline?

LR: It is, yeah. The stats actually say that in Canada only 10% have formal IP, and then only 4.2% have an IP strategy. So I believe that this is a growing market, especially when we look at things in terms of COVID-19, with the investments that we're making into the healthcare sector, or even in telecommunications or information communications technology. As we put more focus on those sectors that are knowledge-based, and the way the provinces are encouraging IP education and investing from a tax perspective, such as Quebec lowering tax rates for IP-related revenues, that will create a new era of IP awareness that will encourage more companies to actually go for patents, to trademark their brands, and to copyright their written works.

So yes, I do realize that it is a small market right now, but I believe it's only going to grow. The opportunity for us now is to provide the capital. Part of the problem in the past has always been the difficulty in accessing capital. While we're addressing the capital part of the problem, now we've got an opportunity to say that, yes, we will help increase that marketplace.

Patrick Latour: In the 20 or so years I’ve been doing this, you can see that the industry has shifted from very capital-intensive industries that were easier to finance. Today, we’ve been going down the path of learning how to finance intangibles. It's a different approach. In the past, when we assessed the value of a company, it was more general. We’d look at the value of the company and the value of the assets, and then the difference must be intangible. It’s very notional, we didn’t really define it. So what Lally’s team is doing is focusing on the value of IP. Once you have that knowledge, you can start financing with bigger amounts because you have the conviction. They’re really bringing a unique, fresh perspective that's differentiated. I’m excited about that because as we do this we will continue to learn. This is a first in Canada and we're very proud of it.

R$: What I'm hearing you say is that you're becoming better at defining intangible assets, is that right?

LR: Yes. And on top of that, what the value of that intangible asset is for the company. How it can help them be more competitive, how it can help make them be more profitable, how we can make them have more revenues.

R$: What is a “strong IP strategy”?

LR: When you're looking at a company with a strong IP strategy, essentially it's a well-thought-out plan for how much of their intellectual property they will patent and how much they will keep as a trade secret. And then: What kind of patent is it? Is it going to be a method patent? Is it going to be an app or a process? Is it going to be a registered design? What role does software play in it? Can they develop their own software, in the case of hardware or a device, to make it more reliable? Are the patents well-written, so that it’s difficult for a competitor to design around them?

So there are a lot of things to consider, and it's not just the number of patents. Rather, it’s a question of whether the IP portfolio is doing the right things. We’ve seen instances in the past where companies have large IP portfolios, but when we look at their products, they weren't patenting what was really important for their business.

R$: With the learning curve that you've been through, and the way that education has been emphasized in many of the recent initiatives, how much educating do you need to do with your peers to convince other investors to join you?

PL: For us, the vision of having this envelope is not just about doing deals. Of course, we will be helping companies, but we also want to take a lead position in the market to create the ecosystem and really take an active role in getting people together. Once you have those participants, then you get to the next step.

LR: Yes, definitely. It's not just about capital. It’s also, How do we convene what I call the IP village? So who are the IP stakeholders all around the country and also internationally that can help us develop a supportive ecosystem. That starts with education and awareness, and from there grows in terms of forming connections to help these companies get the right advice at the right time for the markets that they want to enter. It starts with us to a certain extent, because we do have a broad national reach. As we launch our website, there will be more information on how we can create that online community in order to bring everyone to the table, and make everyone aware of what's already out there. So we're not here to recreate any wheels. It's really to identify the players and increase the awareness for the general SME population so they know who to turn to at the right time of their development.

PL: Remember ten years ago we were talking about recurring revenue models, and that conversation was still in its infancy. We adjusted our practices to value companies based on that model. All banks have finally gone down that path, but it takes a while. So before it becomes the norm, we need trailblazers like BDC. Now we're talking IP specifically, so the dream is that in another 10 years, we’ll have brought the market along with us.

R$: There has been a lot of reference to the fact that Canadian universities are spending a lot of money on research obviously but generating very little income from licensing. How are they part of your ecosystem?

LR: They definitely play a big role. They’re seeing these companies or these inventors before we do, so it's really more of a distribution channel for us to get the word out there about the capital that we provide. And at the same time, they're knowledgeable about the companies and understanding which ones will most likely be more of a product company and which ones will be a pure licensing play. Part of our role is to also support these pure licensing companies. So over time, it's a question of how do we also provide the right sort of financing products. The university tech transfer offices will definitely help us there, because that's where a lot of the IP is. Identifying the promising companies very early on would definitely help us broaden our reach.

R$: Lally, you’ve been doing this type of work for a long time. Did you work with many university spinoff companies?

LR: Yes. A lot of them spent at least seven to ten years before they commercialized anything. Those years were spent spinning out of the university and developing the product. Some of them started off licensing that technology or producing customized solutions for another company. It was only after that that they realized that they can now produce their own products and go out into the market.

R$: In which Canadian sectors are you seeing the fastest growth in IP filings? Are you focusing on any knowledge-based industries in particular?

LR: We are focusing on areas where we know that there's a great need and very little in terms of readily available capital: hardware companies, medical device companies, life sciences, even some consumer products and some manufacturing technologies.

R$: I'm curious about the origin story for this envelope. Are there other similar funds that you looked at?

PL: We’ve been discussing with Quantis and Lally for years, we've known each other in the ecosystem. At BDC, we were asking what else we can do to support the IP strategy. The reality is that we knew we weren't going as deep in valuing the IP and we didn't have the wherewithal inside the bank to do it. And so it was a decision to either build from scratch with new members or do we actually get people who know what they're doing and bring them into the bank? Lally and the team already have the experience and knowledge. The mission was really aligned. Now we're out of the gate running.

Intangible financing is still very difficult for traditional lenders. There are alternative lenders, but a lot of the lenders will want the history of earnings. BDC Capital, we're in a lot of the continuum of risk. So what my team typically does for more mature businesses, the risks are pretty well available and known in the market. But in between the venture capital and our typical business, there are a lot of earlier stage companies that have been working for a long time and have IP, but it’s very hard to write a big cheque. What were we missing? We were missing the knowledge. Having the team that has the knowledge brings us the conditions to be able to say that we're comfortable now.

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